Why the Pullback in SNAP Stock Might Be Cause for Optimism

Trading in Snap (NYSE:SNAP) has been relatively ugly of late. The SNAP stock price twice has touched $18 in recent months. Each time, it pulled back rather sharply. SNAP dropped nearly 6% in trading on Friday, Sept. 27 and is down modestly as of this writing.

Why the Pullback in SNAP Stock Might Be Cause for Optimism

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Those moves might be cause for concern and frustration. The two failures at $18 and the quick pullbacks suggest potential technical weakness. Meanwhile, SNAP has been one of the market’s best stocks so far this year.

Among stocks with a market capitalization above $10 billion, only Roku (NASDAQ:ROKU) has done better in 2019. Some shareholders no doubt are disappointed the rally has stalled out.

But in the context of the tech market at the moment, sideways trading isn’t a bad thing. Rather, from a longer-term perspective, it might well be a good thing. ‘Snapchat stock’ is precisely the kind of stock that should be plummeting right now. The fact that it isn’t, suggests investors finally have trust in a company they were leaving for dead less than a year ago.

Growth Names Tumble

Somewhat quietly, there’s been a notable revaluation among unprofitable growth companies. As I wrote just last week, it looks like the bubble in Shopify (NYSE:SHOP) has burst. ROKU went parabolic to the upside in August and has given back all of those gains in falling over 40% in a matter of weeks.

Recent IPOs – at least the unprofitable ones – keep getting hammered. Uber (NYSE:UBER), Lyft (NASDAQ:LYFT), and Chewy (NYSE:CHWY) all sit at post-IPO lows. Slack Technologies (NYSE:WORK) executed a direct offering, and had traded straight down before a bounce on Monday. Cannabis stocks have been struggling for some time, but there’s been a sudden and odd focus on profitability in that space of late.

It’s not entirely clear what has caused the reversal in sentiment. I posited last week relative to Shopify that the debacle of WeWork’s failed IPO might be a factor. No company has better highlighted the perils of the “growth at any price and any valuation” mindset.

It’s also possible that the stocks just ran too far. For the likes of Roku and Shopify, in particular, even aggressive growth projections seemed more than priced in.

Whatever the cause, it’s clear that overall sentiment toward high-growth, unprofitable companies has shifted. Whether that’s a permanent change or a short-term blip remains to be seen.

The SNAP Stock Price Holds Up

Amid that change in sentiment, SNAP stock would seem to be a prime candidate for a sell-off. It, too, remains unprofitable even on an Adjusted EBITDA basis. I’ve come around to the story somewhat, but still see valuation as potentially problematic.

Competition for ad dollars from the likes of Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) represents an ongoing risk. And the 191% gains YTD would seem to make the stock a prime candidate for profit-taking.

And yet, the performance really hasn’t been that bad. The stock has touched $18 twice (but briefly both times). The stock closed at $17.61 on July 24, the day after a blowout second-quarter report. It’s only declined by 9.5% since then.

Meanwhile, other stocks that look an awful lot like a Snapchat stock have fallen double-digits – or worse. Roku is off 40%+ and SHOP 25%+. Lyft, too, posted a well-received earnings report – and lost has one-third of its value since then.

There’s no real news impacting any of these companies (with the possible exception of ROKU, which has been pressured by worries about competition). It’s not like SNAP was, or is, cheap: it still trades at nearly 15x revenue. And so the divergence in performance can really only be explained by one factor. Investors simply aren’t tossing SNAP stock into the basket of stocks that have run too far.

Why It Matters

That willingness to (mostly) stick with the stock matters going forward. It means that investors have more trust in the Snapchat model than they did less than a year ago, when the SNAP stock price was below $5. It means that the market is willing to ride out a bit of storm with SNAP, trusting that it will come through the other side.

That alone doesn’t make SNAP a buy. It’s possible the pressure on growth stocks could continue. Snap still has a lot to prove in terms of growth and profitability. But it does strengthen the case here.

The market isn’t treating the huge YTD rise in SNAP as the sign of a bubble. It’s reacting to a better business on a path to EBITDA profitability and, hopefully, positive free cash flow. As long as Snap can prove with earnings next month that it’s still on that path, the SNAP stock price should resume its rally.

As of this writing, Vince Martin is long shares of Chewy. He has no positions in any other securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/pullback-snap-stock-price-cause-optimism/.

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